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Monday July 5, 2004 - 12:43:36 GMT
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Forex Trading Strategies - July 5th 2004

EUR/USD set for breach of 1.2350 top -- focus is 1.2500 next time around; GBP/USD aims at 1.8500, then 1.9100

FX focus will now turn to longer-term issues, such as ever rising funding requirements. The spotlight will return to the burgeoning current account deficit, with negative implications for the dollar.


- Japan's economic recovery is gaining momentum as it spreads to service companies from manufacturers and beyond major cities, Bank of Japan Governor Toshihiko Fukui said. ``The economy is gradually gaining momentum to return to the path of sustainable growth,'' Fukui said in a speech at a conference held at the bank in Tokyo. He said the recovery needs further momentum to achieve sustainable growth. The central bank pushed overnight rates close to zero by raising its target for reserves available to lenders in March 2001, aiming to stop deflation and support economic growth.

FX Market Summary

The yen fell in Asia today after a decline in Japanese stocks damped demand for the nation's currency and polls suggested Prime Minister Junichiro Koizumi's party may lose seats in an election Sunday. Japan's yen weakened against the currencies of all 16 of its biggest trading partners. Against the dollar, the yen weakened to 108.55 at 1:02 p.m. in Tokyo from 108.32 late Friday in New York. It also fell to 133.69 per euro from 133.43.

Australia's dollar held at a five-week high on expectations the central bank will increase interest rates later this year and the Federal Reserve will raise U.S. borrowing costs gradually. The Australian currency surged Friday after a report showed fewer U.S. jobs were created in June than expected, damping prospects the Fed may quicken the pace of rate increases. A report today showed Australian job advertisements rebounded in June, boosting expectations the Reserve Bank will raise its key percent interest rate for the first time this year. Australia's dollar bought 71.36 U.S. cents at 1:14 p.m. in Sydney, little changed from late New York trading on Friday when it climbed more than 1 percent.

The unimpressive economic data weighed on the dollar on Friday, which finished marginally lower against the yen but fell a sizable 1.3% versus the euro.

There was little in the way of euro zone data on Friday, except euro zone producer prices, which surged 0.6%(m/m) in May and 2.4% (y/y), which was higher than expected. Much of this rise was due to higher energy prices. In addition, comments by ECB Chief Economist Issing pointed to concern over inflation. His comments suggested that the ECB may consider a rate hike sooner rather than later. His comments were seen as fairly hawkish statements regarding price growth. This tell us is that the ECB is closely watching inflation patterns, though it gives few clues as to possibly policy action.

Monetary base statistics for Japan showed only a 4.4(y/y) advance for June on Friday after growing at a double digit pace through March. This is a troubling development because liquidity growth was one piece of the inflation puzzle that used to be in place in Japan. On Friday, the yen slumped against the dollar on the back of declines in the Nikkei, which fell 1.5%. The fall in the yen comes on several concerns though. Not only are markets a little edgy ahead of the June payrolls number, but ahead of the long weekend, there are obvious concerns about terrorist threats.

A word about interest rate hikes:

There are four reasons why the rise in U.S. interest rates is unlikely to provide a notable boost the dollar:

First, the dollar has already appreciated markedly since the beginning of the year, fueled, in part, by the prospect of interest rate hikes. Currency markets, much like other financial markets, have already priced in higher interest rates.

Second, U.S. interest rates are at historic lows. Thus, it will be sometime before absolute interest rate differentials turn favorable for U.S. assets.

Third, as the Fed has noted once more, the intention is to tighten policy at a measured pace. Thus, differentials will improve only at a gradual pace.

Fourth, the trade weighted dollar has declined, on average, by 1.4% during the six months following the beginning of prior tightening cycles. The historical evidence would, thus, argue for depreciation, not appreciation, in the dollar.

With the initial tightening now fully priced in, the focus will undoubtedly turn to longer-term considerations, such as ever rising funding requirements. The spotlight will return to the burgeoning current account deficit, with consequent negative implications for the dollar.


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